The Financial Sector in Developing and Emerging Economies

Question 1

What is the role of saving and investment in promoting economic development?

Answer 1

Economic growth in its self doesn’t guarantee economic development but it is a necessary ingredient. Since long run economic growth is the expansion an increase in aggregate supply investment has large importance as it increases a countries productive capacity.
Since many firms finance investments with loans, a substantial amount of saving must be happening so the bank has funds that it can loan to these banks.

Question 2

What is the Harrod- Domar model?

Answer 2

That GDP is determined by the savings ratio and the capital output ratio. Essentially, saving is necessary and these savings must be able to be transformed into productive investment

Question 3

What is the savings ratio?

Answer 3

That GDP is determined by how much an economy can save.

Question 4

What is the capital-output ratio?

Answer 4

Economic growth is determined by how productive investment is.
The amount that has to be spent to increase national output by a unit.

Question 5

What are the steps of economic development as according to the Harrod - Domar model?

Answer 5

People save- Which enables investment- Investment allows capital to increase and technology to be improved.
This leads to an increase in output and incomes which leads to an increase in saving according to (Marginal propensity to save) and the cycle begins again.

Question 6

Why might the Harrod- Domar model fail to work smoothly?

Answer 6

The model theorises that saving is the key to economic development as otherwise investment will be limited, however the flow of savings may be limited in LDC’s as people may prioritise spending their money on resources of consumption

Question 7

What is the equation for the Harrod- Domar Model?

Answer 7

Growth rate of output= Savings ratio/ Capital- output ratio. pg 335

Question 8

Why might it be difficult for savings to accumulate in an LDC?

Answer 8

Many LDC’s have undeveloped financial institutions so if people want to save they can’t do so in a savings account in a bank, instead they save “under the bed”. This money doesn’t easily transfer into loanable funds.

Question 9

Why can lowering the interest rate reduce investment?

Answer 9

Governments may lower the interest rate to encourage firms to borrow to incentivize investment, however they are forgetting that low interest rates can reducing saving meaning there are less loanable funds. This would mean firms wan to invest but don’t have the funds to do so.

Question 10

Why might savings not be converted to investment in an LDC in terms of lack of the entreperneurial factor of production?

Answer 10

There needs to be entrpreuneurs that can identify investment oppurtunities and have the skills to carry them through and willingness to take risks.

Question 11

Why may investment not be productive in LDC’s

Answer 11

The firms need physical capital in order to increase how much they produce, they may have to import capital however this is not always possible when there is a foreign exchange gap.

Question 12

What’s a foreign exchange gap?

Answer 12

When an LDC is unable to import the goods that they need for development because it has a shortage of foreign exchange. Essentially they don’t have enough of other currencies.

Question 13

What can countries do to increase their foreign exchange?

Answer 13

When foreigners buy a countries exports we gain their currency.

Question 14

What is the convergence process?

Answer 14

LDC’s that are beginning to develop adopt technology that has already been used and tested so grow at a more rapid rate than already developed economies.

Question 15

What is the argument against the convergence process?

Answer 15

Many LDC’s don’t have satisfactory human capital, the education system isn’t good enough, the health care is subpar and this makes investment less productive.

Question 16

What are other external ways that investment can be financed apart from domestic savings.

Answer 16

Higher income countries may give flows of overseas assistance, meaning banks have more loanable funds and are more willing to loan to firms.

The LDC may be able to borrow from international capital markets to finance domestic investment.

Multi-National corporations may be persuaded to engage in foreign direct investment.

Question 17

What is the drawback to an LDC’s domestic investment being funded by overseas flows from higher income countries?

Answer 17

These flows are often seen as part of trade policy, in that the other countries expects imports from the LDC such that the LDC looses out as they are giving more than they are receiving.

Question 18

What is the drawback to a LDC receiving FDI from a multinational

Answer 18

Often with the MNC, profit made is not recycled in the economy, often it leaves and goes to the source country of the MNC.

Question 19

What is the drawback to a LDC participating in international borrowing.

Answer 19

The loan has to be paid back eventually and LDC’s may find themselves burdened by debt that they can’t afford to repay.

Question 20

Why do people in LDC’s often struggle to gain the funds needed for small scale projects

Answer 20

There is some market failure in rural credit markets.
Many people in rural areas can’t access the formal finance sector as there is an absence of branch banking and internet banking.

Question 21

Why do loans in the informal credit market often have extremely high interest rates?

Answer 21

There is a very high risk premium and money lenders may not have the means of finding out information on the borrower to assess their likelihood of defaulting.

A moneylender might have a monopoly in the village giving people no other choices of gaining credit.

Question 22

What is microfinance?

Answer 22

As a solution to the difficulty of people in rural areas of LDCs to access the formal financial sector, schemes have been created to provide finance for small scale projects.

Question 23

What is the Grameen Bank?

Answer 23

Originating in Bangladesh, it is a bank that made small loans to small groups of women that would otherwise have to rely on moneylenders. Each group was made responsible for paying back the loan.

Question 24

How successful was the Grameen Bank at supporting economic development?

Answer 24

The loans have been seen to raise income as they charge an interest rate that is close to that of commercial banks, far below what money lenders charge. This enables the women to make greater profit.

This has also increased food consumption, and citizens having enough to eat is a key part of economic development.

Overall living standards have also increased due to the rise of income

Grameen-type credit programmes are now operating in 59 countries across Africa, South-America, Asia and Europe.

Question 25

What does ROSCAS stand for?

Answer 25

Rotating Savings and Credit Schemes

Question 26

What is ROSCAS

Answer 26

This is a microfinance scheme where households would group together and bring their savings together so they had enough to launch small projects. Members take turns to use the joint savings and then pay back the loan so the next person can take their turn.

Question 27

Why is ROSCAS generally not as effective as Grameen -style arrangements?

Answer 27

They are often used to obtain durable consumer goods rather than investment, which is key to economic growth, a necessary ingredient to economic development.
Also, these schemes rely on people trusting the members of their group, confident that when a person takes their turn borrowing money they keep paying into the joint savings.

Question 28

How is the capital-output ratio measured?

Answer 28

It is the ratio of investment to growth.

1/ Marginal Product of Capital
A high number means that a high amount of capital is needed for economic growth to occur, so essentially, the capital is inefficient.

Question 29

What was the problem with the plans that were introduced to aid countries that were in extreme debt to the IMF and World Bank?

Answer 29

LDC’s complained these mainly enabled the rescheduling of debt rather than relieving them of it.

Question 30

What is a major cause of LDC’s becoming trapped in cycle of debt as a result of their own actions?

Answer 30

Some governments may try to invest in short term projects to gain political strength rather than long term investments that would spur on economic growth and enable the country to pay the loan back.

Question 31

Why was the Bank of England reluctant to relieve the debt of the HIPC’s.

Answer 31

They were concerned about the likelihood of moral hazard, that countries would become less likely to pay their debt back if they knew it would be relieved.

Question 32

What was the HIPC Initiative?

Answer 32

An initiative that began in 1995 through the World bank to offer debt relief to the HIPCs.

Question 33

What was the condition that HIPCs had to meet in order to gain debt forgiveness under the HIPC initiative?

Answer 33

They had to demonstrate that they were trying to increase their economic growth and fulfil the steps in the HIPC policy package.

Question 34

What are the 4 main steps in the HIPC policy package?

Answer 34

• Successfully applying policies to improve economic growth.
• Developing a plan to reduce poverty (a Policy Reduction Strategy Paper) (PRSP)
• Encouraging private firm investment
• Diversifying their exports

Question 35

What are Personal Remittances?

Answer 35

Current transfers to residents of a country from non-residents as well as incomes of workers who are employed in another country.

Question 36

Why have personal remittances been increasing?

Answer 36

Globalisation has meant it is easier for people to migrate and work abroad.